Well, another disastrous week on Wall Street in the books. The Dow lost 500+ points this week, giving back most of the gains from the rate cut rally and almost back to the doom and gloom sub-12,000 level, which brings us to the financial media starting to ask questions.
They’re asking the wrong questions, of course. But they are asking at least.
Wall Street has equated rate cut with stock market gain. for years now. When that’s not happening, people are at least starting to ask why.
As the Federal Reserve tries to head off a recession, it’s facing the troubling reality that its primary weapon–interest rate cuts–may not matter anymore.
Despite several rate cuts–including a 1.25 point decline in January alone–the moves have done little more than give the stock market a temporary bounce. Meanwhile, recession worries continue to grow–even among Fed officials themselves.
The problem, analysts, say, is that the rate cuts haven’t encouraged banks to start lending again. After billions of dollars of losses from subprime debt, banks are still reluctant to put money into the cash-starved economy. As a result, doubts are growing that the Fed can do much of anything to get the economy–and the markets–back on solid footing.
“This particular recession may be somewhat immune to monetary stimulus,” says Barry James, president of Cincinnati-based James Advantage Funds. “It’s almost like pushing on a string.”
Banks are essentially caught in a Catch 22. They’re being encouraged to tighten lending standards because of the subprime collapse, but those stricter policies are countering the effects of the Fed’s aggressive rate cuts.
Analysts acknowledge that there’s not much the Fed really can do to jump-start the economy beyond rate cuts. Some suggest, though, that working closely with the Treasury to encourage banks to start lending again might help.
As I’ve stated, the problem is basic bank solvency and not credit. But admitting that large chunks of the financial industry are basically insolvent is something the financial media can’t say out loud.
And yet, that doesn’t change the basic problem. Banks don’t have money to loan not because of credit rates from the Fed, but because they don’t know what the subprime mortgage investments that they have on their books are even worth.
Actual cash on hand at a bank is a fraction of a percent, even over thousands of branches. It’s all paper and electronic, and if it’s all tied up in leveraged toxic crap, it can’t be loaned out.
We’re talking banks unable to meet day to day requirements of cash on hand here. They’re too scared to loan the money out because they need it to stay afloat.
The financial media sees the banks are being stingy with money, but they aren’t digging at why that is.
But they know what they want as far as solving it.
“We’re looking to the Fed for some intervention to help unlock the frozen CDO marketplace,” says Alan Rosenbaum, president of GuardHill Financial in New York, a mortgage brokerage that does not deal in subprime loans. “Until that happens, banks are not going to lend.”
“It’s very difficult for banks to be in the lending business without access to long-term unsecured money,” says Bill Isaac, managing director at LECG in Vienna, Va. “Bringing rates down at the short end I don’t believe would be as effective as trying to find ways to make more lending available to banks. I don’t have the answers. I’m sure that would have to be worked out by the Fed and the Treasury.”
One such effort–special auctions allowing banks to borrow money cheaply from the Fed–has been only modestly successful so far. Though they attracted a lot of interest when they began in December, Thursday’s auction was poorly received, with weak foreign demand sending prices on 30-year Treasury bonds plunging.
What banks want is a multi-trillion dollar bailout of the industry. They don’t want to be on the hook for their bad investments. They want us to pay for it.
When bankers say “We want the Fed to…” simply substitute what comes next with the words “magically bail us out.”
To do that, they will have to create money out of nothing. Vast, massive sums of it. That will cause hyper-inflation. We’ll print our way out of it!
But not everybody is being Pollyanna about this. Some people are counting on a continued disaster.
Bear Stearns Cos., the U.S. securities firm that posted its first-ever loss last quarter on mortgage writedowns, has more than $1 billion of trades that profit if subprime home loans and bonds continue to deteriorate.
The “short” positions on subprime mortgage securities increased from $600 million at the end of November, Chief Financial Officer Sam Molinaro said today at an investor conference in Naples, Florida. The company also reduced its holdings of so-called collateralized debt obligations and underlying bonds, Molinaro said.
The sinking value of assets tied to mortgages led to Bear Stearns’s fourth-quarter loss of $854 million, and Molinaro said today that one of the firm’s biggest mistakes was “not being conservative enough and bearish enough on the subprime market.” The firm has reversed “long” subprime trades that stood at $1 billion at the end of August, Molinaro said.
“There’s definitely a lot of short plays out there,” said Mark Adelson, a founding member of Adelson & Jacob Consulting in Long Island City, New York. Some subprime bonds “could easily be bad enough that they don’t pay off a penny,” said Adelson, a former Nomura Holdings Inc. mortgage analyst.
That’s right. One of the major investment firms on Wall Street is betting the markets are going to get worse and plan to make a billion dollars if they are right.
How long do you suppose it’s going to take before the rest of the market catches on?
Meanwhile, the hyper-inflation warning signs are already rolling in.
Wheat rose to a record for a third day on the Chicago Board of Trade as the U.S. forecast its lowest inventories in 60 years.
U.S. stockpiles will drop to 272 million bushels at the end of May, 6.8 percent less than expected a month ago and down 40 percent from the prior year, the Department of Agriculture said in a report today. Inventories will be the lowest since 1948 when farmers grew less and shipped more wheat overseas to help rebuilding countries after World War II, economists said.
Higher costs for commodities including wheat and fuel eroded fourth-quarter profit reported this week by Kellogg Co., the largest U.S. cereal-maker. Sara Lee Corp. Chief Executive Officer Brenda C. Barnes said Feb. 6 the company raised bread prices “to keep pace with historically high wheat costs.” Wheat has more than doubled in the past year.
“We have a limited supply, and we got confirmation of that this morning,” said Jamey Kohake, a broker at Paragon Investments in Silver Lake, Kansas. “We had the early frost last year and drought pretty much worldwide, and we kept demand at a rapid pace, so our stocks started to dwindle.”
Wheat futures for March delivery rose 30 cents, or 2.8 percent, to a record $10.93 a bushel on the Chicago Board of Trade. The contract rose the 30-cent exchange limit for five straight days. The 16 percent gain this week is the biggest in history.
Basic food prices are climbing at record rates now. Wheat, corn, basic commodities, and all of it exacerbated by rising oil and fuel prices. It’s a nasty spiral that will start making everything else cost a lot more very quickly.
It’s only going to get worse from here on out. Count on it.
